Lecture 1 – SFM Introduction 1/15/2019

Objective of financial managers Corporate Finance theoreticians generally agree that the objective of a firm is to maximize wealth Whose wealth? whether it should be the wealth of shareholders or the wealth of the firm, which includes bondholders and preferred stockholders Shareholder wealth maximization rule requires managers to work towards a sustainable increase in the price of the firm’s stock 1/15/2019

Alternative to the above rule is to maximize profit, social value, or growth of the firm The underlying assumption is that, an increase in any of these proxies results in an increase in the value of the firm (alternatively, shareholder value) Maximize Profit? Increase sales, suppress expenses, extract the last rupee from the customer, pay the lowest possible price to suppliers, pay less salaries to employees, 1/15/2019

Can social responsibility be an objective? Businessmen are supposed to be socially responsible But social welfare activities have conceptual propblems? What is right or wrong, how much to spend on social responsibility? Moreover, what was considered moral 30 years ago could be immoral now? 1/15/2019

Can growth be an objective of a firm? Business in pakistan, india and south Korea are dominated by family groups, and conglomerates. Businesses groups in south Korea are called chaebol, typically own 30—50 companies in all key business areas; and the big five—Daewoo, Samsung, Hyundai, LG, and SK—account for 20 percent of all borrowing and contribute to almost 50 percent of GDP 1/15/2019

Productivity in South Korea is about half that of US levels Debt ratios at the top 30 chaebol are in the range of 550 percent; they suck up a major portion of the available credit and drive out smaller businesses The chaebol understand only one language: borrow to the hilt; focus on size and not profit; focus on growth and not productivity; invest aggressively and acquire companies Productivity in South Korea is about half that of US levels 1/15/2019

When earnings fall due to recession, competition, or some such thing, these companies will default on borrowings To summarize, growth, though important, need not necessarily lead to an increase in shareholder value 1/15/2019

Do Firms Pursue Multiple Objectives? In a survey of management views on alternative objectives, Porwal found in his sample that in 67 percent companies—with high profitability—the first preference is given to the objective of maximizing percent ROI and, in 33 percent companies, the first preference is given to the objective of maximizing aggregate earnings 1/15/2019

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Impediments to shareholder wealth maximization There could be potential conflict of interest between shareholders and bondholders, managers and shareholders, majority and minority shareholders. So, maximizing wealth of one group could be achieved at the expense of other groups Shareholders vs Bondholders Managers vs Shareholders Shareholder vs Shareholder 1/15/2019

Conclusion The objective of a firm should not be to make a profit or even maximize profit, increase market share or sales, but to maximize shareholders’ wealth But this should not be achieved at the expense of other investor groups Financial markets are efficient to some extent, they can see whether a firm is adding value or not; this will be reflected in the share price of the firm 1/15/2019

What is strategic financial management The identification of the possible strategies capable of maximizing an organization's net present value, the allocation of scarce capital resources among the competing opportunities, and the implementation and monitoring of the chosen strategy so as to achieve stated objectives 1/15/2019

The satisfaction of the interests of the shareholders should be perceived as a means to an end – maximization of shareholders’ wealth.

Since capital is the limiting factor, the problem that the management will face is the strategic allocation of limited funds between alternative uses in such a manner, that the companies have the ability to sustain or increase investor returns through a continual search for investment opportunities that generate funds for their business and are more favorable for the investors. Therefore, all businesses need to have the following three fundamental essential elements: 1/15/2019

A clear and realistic strategy; The financial resources, control and systems to see it through; and The right management team and processes to make it happen So we can sumarise as follows: Strategy +Finance+ Mgt =Fundamentals of Business 1/15/2019

Strategy A method or plan chosen to bring about a desired future, such as achievement of a goal or solution to a problem. (businessdictionary.com) 1/15/2019